Impact and Sustainability: similar but different

…but the similarities stop there

Impact investing isn’t ‘better’ than sustainable investing, it is simply more demanding, with a stricter set of rules. Hence, for investors and fund managers, it means fishing from a shallower pond of potential investment candidates.

In addition to financial returns, which generally constitute the primary objective of sustainability-focused funds, impact funds seek to deliver on an ‘impact objective’ as well. To evidence the meeting that impact objective, managers of impact funds have an obligation to measure the positive outcomes that have been achieved, and report on these at least once a year. These are onerous requirements, but are essential to maintain the integrity of the impact investing approach.

Another hallmark of impact investing is ‘intention’; the positive impact a company delivers cannot be accidental. There has to be a genuine intent to engage in activities that directly contribute to making the world a better place. Many sustainability stocks lack this essential sense of ‘positive purpose’ or intention and, therefore, do not qualify as impact stocks.

‘Additionality’ is another determining tenet of impact investing. In simple terms, this means that the given impact would not have been achieved if a specific company did not exist. Looking at it the other way, many commoditised solar equipment makers, for example, might be sustainable, but would not reach that additionality threshold as they are easily substituted. Conversely, companies pioneering technological breakthroughs, such as low-cost gene sequencing methods or next generation energy-efficiency simulation software, would qualify as additional.

The principle of ‘materiality’ also weeds out certain sustainable stocks from impact portfolios. The activity or products delivering impact must represent the bulk of a company’s revenue, or it will fail the impact materiality test.

Last but not least, the ‘affordability’ or access factor, is exceptionally important in distinguishing between impact and sustainability. Take the area of education as an example. Educating wealthy students in the US would be unlikely to count as impact. By contrast, providing affordable, quality education to under-served young people in Brazil probably would. In the same vein, evidencing affordability and access is also critical for impact investments in sectors such as healthcare and financials.

Inevitably, the more stringent set of rules imposed on impact investors means that there are a number of popular sustainable stocks that would not be found in impact portfolios. These may be good companies with sustainable business models, but they just don’t pass the test when it comes to creating measurable impact. While the popularity of sustainability-focused and impact funds is greatly welcomed, and indicative of a thriving Responsible Investment ecosystem, this growth needs to be accompanied by full transparency and a clear explanation of their different attributes. This is the only way investors can make informed choices, and ensure the fund management industry remains true to its goal of providing genuine sustainability-focused and impact strategies.

[1] https://www.theia.org/sites/default/files/2019-11/20191118-iaresponsibleinvestmentframeworkglossary.pdf